I am always astonished that many traders don’t really understand the indicators they are using. Or, even worse, many traders use their indicators in a wrong way because they have never taken the time to look into it. In this article, I will help you understand the STOCHASTIC indicator in the right way and I will show you what it does and how you can use it in your trading.

## What is the Stochastic indicator?

The STOCHASTIC indicator shows us information about momentum and trend strength. As we will see shortly, the indicator analyses price movements and tells us how fast and how strong the price moves.

This is a quote from George Lane, the inventor of the STOCHASTIC indicator:

*“Stochastics measures the momentum of price. If you visualize a rocket going up in the air – before it can turn down, it must slow down. Momentum always changes direction before price.” – George Lane, the developer of the Stochastic indicator*

## What is momentum?

Before we get into using the Stochastic, we should be clear about what momentum actually is.

Investopedia defines momentum as “** The rate of acceleration of the price of a security**.” via Investopedia

I am always a fan of going into how an indicator analyzes price and without getting too deep into the mathematics, this is how the indicator analyzes price:

The stochastic indicator analyzes a price range over a specific time period or price candles; typical settings for the Stochastic are 5 or 14 periods/price candles. This means that the Stochastic indicator takes the absolute high and the absolute low of that period and compares it to the closing price. We will see how this works with the following two examples and I have chosen a 5 period Stochastic which means that the Stochastic only looks at the last 5 candlesticks.

## Example 1: A high Stochastic number

When your Stochastic is at a high value, it means that price closed near the top of the range over a certain time period or number of price candles.

The graphic shows that the low was at $60, the high at $100 (range of $40) and price closed almost at the very top at $95. The Stochastic shows 88% which means that price only closed 12% (100% – 88%) from the absolute top.

**How a high Stochastic is calculated:
**The lowest low of the 5 candles: $ 60

The highest high of the 5 candles: $ 100

The close of the last candle: $95

The value of the Stochastic indicator: [(95 – 60 ) / (100 – 60)] * 100 = 88%

You can see, the high Stochastic shows us that price was very strong over the 5 candle period and that the recent candles are pushing higher.

## Example 2: A low Stochastic number

Conversely, a low Stochastic value indicates that the momentum to the downside is strong. In the graphic we can see that price only closed $5 above the low of the range at $50.

**How a high Stochastic is calculated
**The lowest low of the 5 candles: $ 50

The highest high of the 5 candles: $ 80

The close of the last candle: $55

The value of the Stochastic indicator: [(55 – 50 ) / (80 – 50)] * 100 = 17%

The Stochastic of 17% means that price closed only 17% above the low of the range and, thus, the downside momentum is very strong.

## Overbought vs Oversold

The misinterpretation of overbought and oversold is one of biggest problems and faults in trading. We’ll now take a look at those expressions and learn why there is nothing like overbought or oversold.

**The Stochastic indicator does not show oversold or overbought prices. It shows momentum**.

Generally, traders would say that a Stochastic over 80 means that the price is overbought and when the Stochastic is below 20, the price is considered oversold. And what traders then mean is that an oversold market has a high chance of going down and vice versa. This is wrong and very dangerous!

As we have seen above, when the Stochastic is above 80 it means that the trend is strong and not, that it is overbought and likely to reverse. A high Stochastic means that the price is able to close near the top and it keeps pushing higher. A trend where the Stochastic stays above 80 for a long time signals that momentum is high and not that you should get ready to short the market.

The image below shows the behavior of the Stochastic within a long uptrend and a downtrend. In both cases, the Stochastic entered “overbought” (above 80), “oversold” (below 20) and stayed there for quite some time, while the trends kept on going. Again, the belief that the Stochastic shows oversold/overbought is wrong and you will quickly run into problems when you trade this way. A high Stochastic value shows that the trend has strong momentum and NOT that it is overbought.

## The Stochastic signals

Finally, I want to provide the most common signals and ways how traders are using the Stochastic indicator:

**Breakout trading:**When you see that the Stochastic is suddenly accelerating into one direction and the two Stochastic bands are widening, then it can signal the start of a new trend. If you can also spot a breakout out of sideways range, even better.

**Trend following**: As long as the Stochastic keeps crossed in one direction, it shows that the trend is still valid.**Strong trends:**When the Stochastic is in the oversold/overbought area, don’t fight the trend but try to hold on to your trades and stick with the trend.

**Trend reversals:**When the Stochastic is changing the direction and leaves the overbought/oversold areas, it can foreshadow a reversal. As we’ll see, we can also combine the Stochastic with a moving average or trendlines nicely.**Important**: when we look for a bullish reversal, we need to see the green Stochastic line to get above the red one and leave the overbought-oversold area.

**Divergences**: As with every momentum indicator,**divergences**can also be a very important signal here to show potential trend reversals, or at least the end of a trend.

## Combining the Stochastic with other tools

As with any other trading concept or tool, you should not use the Stochastic indicator by itself. To receive meaningful signals and improve the quality of your trades, you can combine the Stochastic indicator with those 3 tools:

**Moving averages**: Moving averages can be a great addition here and they act as filters for your signals. Always trade in the direction of your moving averages and as long as price is above the moving average, only look for longs – and vice versa.

**Price formations:**As breakout or reversal trader, you should look for wedges, triangles and rectangles. When price breaks such a formation with an accelerating Stochastic, it can potentially signal a successful breakout.**Trendline**: Especially Stochastic divergence or Stochastic reversal can be traded nicely with**trendlines**. You need to find an established trend with a valid trendline and then wait for price to break it with the confirmation of your Stochastic.

## Recap: How to use the Stochastic indicator

You might not need the Stochastic indicator when you are able to read the momentum of your charts by looking at the candles, but if the Stochastic is the tool of your choice, it certainly does not hurt to have it on your charts (this goes without a judgment whether the Stochastic is useful or not).

More importantly, this article is meant to make you realize how little you might know about the tools you use for your trading. Additionally, there is a lot of wrong knowledge being shared among traders and even widely used tools such as the Stochastic indicator is often misinterpreted by the majority of traders. Do not blindly believe what other people tell you, do your own research and build your trading knowledge.

This information is excellent quality, it is the first time I have really understood what stochastic is telling me. Many thanks.

That is great to hear 🙂

Great explaination sir….

Thanks for opening my eyes. Thanks again!

I sincerely appreciate your explanation on this subject…

Thank you

Great article, as a long time trader I never look at overbought or oversold, to me that’s total “codswallop”, sorry about the wording. I see a lot of newbie traders on chatrooms commenting about price being overbought & not taking a trade. I’ve never gone for that never look at it, just exactly like you say if it’s high keep going up, if low visa versa. Great article keep it up.

Sensacional a interpretação do indicador.

I do appreciate this very article.

Nicely explained. Very well understandable in simple language

Brilliant explanation. Very comprehensive.

Q: You mentioned when price is above MA, it is Long not Short. There are many MA, which one are you referring to?

The vision cleared, thank you

First Time I”ve seen or heard this explanation, been trading for six years????

Thank You

Nice adrticle,it is very

Thanks for this

Awesome

This information is excellent quality

many thanks

Thanks for this. You’ve made it easy to understand.

What an eye opener! Thanks alot.

THANKS FOR THIS WONDERFUL INFORMATION.PLEASE I WILL NEED MORE OF YOUR IDEOLOGY ON “Stochastic indicator”.

I don’t have words to describe the posts of your blog guys . I’m just a young Brazilian starting in the shark sea . So grateful to find these posts I open my eyes everytime I read a post . Thanks good bless to your life .

Thank you, Matheus for such a nice comment 🙂

Greeting to Brazil.

Rolf

Voila!

Man!! This isa game changer. I’m Rookie seeking knowledge. This is priceless!!!

Thank you Sir!!

Glad you find it helpful 🙂

Hi, nice article, but I still have some doubts, the formula to high and low is the same? Usually we see two lines, K and D, and they receive different parameters, in trandingview.com they are by default 13 and 4… What do they mean? Sorry if this is such a noob question, I am just starting trading. Thanks a lot.

what does it mean when the stochastic is going down but the trend is going up?

It can be a hidden divergence

Rolf

Excellent explanation Bro. I have never seen such a wonderful and completely logical explanation of any indicator. Your research shown different dimension of technical analysis. Thank you so much for a such a helpful post.

excellent explanation , yet simple…. good info for beginner like me…

regards

nirvan

For the first time I now understand what the stochastic is telling me and how to properly use it. Thank you so, so much! Greetings from South Africa.

You articles on indicators are very good, well explained with good examples.

wow! what a explanation ,just describe in details, which is a eye opener for every new trader. today i got to know , how to used stochastic oscillator. Thanks you a million for giving us such valuable lesson. every trade set up posted in your blog is a cornerstone for newbie. And I am Indian and a newbie in stock market and places few trades in INDIAN STOCK MARKET and end up most of my trade with losing, which incurred nearly 1100$ which nearly 57000k Rupees in INDIAN Money. so please keep updating new trade set up from which we can learn to become a succesful trader.

Thanks for leaving such a nice comment. I am glad you find it helpful 🙂

I’ve seen that the “overbought and oversold” thing is a myth from another pro trader too. It’s so widely taught though that so many retail traders are trading this way. This article (and all of them really) are absolute gold! People really do need to dig more and learn what their indicators are for and how they work before using them. I’m so glad I’ve found your articles. They have helped me immensely with my trading. Thanks!

Yes, this explains minute points about Stachastics in very good manner. thanks

Thank you so much Mentor Rolf. Such a blessing and your labor to give us guidance how to use these indicators is indeed a Diamond-digged! God bless you and prayers of good health to you and your family!

The devil is always in the details.

What a powerful detailed explanation of stochastic indicator.

Please Do you have any write up on multiple time frame trading using stochastic indicators.

What moving average would be appropriate for day trading? 50?

Also, what are the ideal settings for the stochastic? I have 5,3,3 as I day trade. Please advise.

thank you so much. golden information

this is very helpful… thanks … I only need to know about the CCI Indicator now

Thank you so very much. This was brilliantly explained.

Nice explanation. It is very useful. Thank you

Great stuff explained with ease.. Thanks somuch…

Thank You Sir,

its very informative info.

would like to learn more from you.. Thanks!!

Very nicely described and correlated with other tools. Very informative and off course in simple words.

wow great knowledge sharing …. very simplified just really awesome explanation … thanks alot …

Thanks lot. But I need an explanation. If given, I would be so grateful.

I have heard that, ” if stochastic points upward for 30/40 seconds, then I sshould open an up trade (Buy) and vice versa. ” If it is so, so what’s the exact time to open an OP?

Nice and clean explain. Fine work.

Thank you very much for taking the time to share such valuable knowledge!

We really appreciate all your hard work and how much time you invested in these blogs!

Congratulations friend, your blog is undoubtedly the best in technical terms and mindsets. Thank you and I await you in Brazil.

Thanks Rudolf. Precise explanation on how to calculate stochastic indicator and how to use it.

God bless You

Thanks for excellence information

Thanks for giving us this keys ☸️

This is incredible i must say ….. Thanks for the wonderful post on stochastic indicator… stay blessed

Thanks for this excellent information.

Very valuable information, all along I took stoch trading to be overbought and oversold- thanks

very educative. thank you

Excellent information. Thank you !!

Wow!!!

I’m well granded in stochastic now with this article cos prior to reading this article I ve little knowledge about it.

Thanks so much Rudolf .

As a newbie from Nigeria I now know what and how to use stochastic oscillator.

This is the best article in Stochastics ever . and i have read a lot of them , a question here: which settings you recommend for this indicator ? thanks – Danke sche!

This is very nice information. Thank You…

I want to know how to make use of the indicator especially when there is a divergent candle stick confusing me very well

Hello,

Thanks for the great and well-explained article. Two quick questions.

1) For stocks, what is the typical setting you recommend? Candlesticks (1 Day?), Stochastic (14 day?) or any other?

2) Do Bollinger Bands fit in this stochastics for range breakouts…if yes, with what settings?

Please let us know.

This is the best information

In your chart I can see a stochastic indicator has two lines. But when I use it I find only single line. How can I make my stochastic look with two lines as yours?

My trade result have greatly improved listening to you Rolf.

Your ability to keep it simple is noteworthy.

Thank You

Excellent explanation! Thank you so much!

Thank u so much

That was great thank you very much

Let me go and print papers

Thank you for the correct info I really appreciate!

Life saver! You, Sir, are a real trader. That oversold and overbought nonsense lost me 90% of my net worth. Thank you for this! Time to trade facts instead of propaganda.

Thank you! Great explanation. However, it leaves me with two questions:

– After you made a strong point about the fallacy of “Overbought” and “Oversold”, you started referring to the above-and-below the line situations as overbought and oversold yourself. Is this because that’s what everyone else calls it? I am curious because I looked up the details on modifying the indicator provided by my brokerage firm’s charts, and they refer to it as overbought and oversold also.

– Also, in looking at the that same Stochastics indicator, my brokerage firm’s chart provides only ONE line, not two, hence no divergences. In your opinion, does this render the indicator useless? (my opinion is it still has some use.)

Very nice explanation. Very clear and objective.

I feel so lucky to find this combine analysis of using indicators . Thanks a lots and lots for your nice research .

Good, because I never understood oversold / underbought because when I look on the indicator if it goes above 80 or below 20 it usually means it will keep trending up, NOT reversing. Even my first forex course taught it that way but just a little bit of examination made it clear that didn’t make any sense. But when it goes back below 80 and above 20 it often reverses, so just that seemed like a weak trend reversal signal

Thank you for sharing your knowledge. Trading since 2014 with my own skill set and market news. But this is game changer. you covered basis with ease. Thanks a lot.